It’s not hard to identify the factors behind the bounce that many expected to come much earlier. Speculators who were uncommonly bullish on crude above $100 a barrel this summer as evidenced by non-commercial open interest in the futures had turned unusually bearish by the year’s end, once again courting disappointment.

Meanwhile, the parade of aggressive capital spending cuts announced by shale producers in recent months raised the likelihood that supply will tighten later this year. Hydraulically fractured shale wells decline much faster than traditional vertical ones, so that merely keeping output level requires constant investment in additional drilling.

The capital spending cuts have been matched by a dramatic 30% decline in the number of active U.S. drilling rigs since October, based on the weekly count maintained by Baker Hughes.


Source: Bloomberg

But the rapid idling of rigs may not have as great effect on output as that percentage would suggest, since the least efficient equipment drilling the least promising wells tends to be mothballed first.

Meanwhile, drillers continue to innovate in ways that lets them get more crude and gas for each dollar spent. New wells are getting fracked with dramatically higher sand volumes as a cost-effective technique that tends to boost early production. And some of the wells drilled a few years ago will be re-fracked using the knowledge gained since in a process that does not require a rig at all.

For all the spending cuts announced so far, most of the companies announcing them still expect to increase or hold steady their output this year. Two recent updates by companies in our portfolios typify the trend.

On Feb. 10, Jones Energy (NYSE: JONE) said 2015 production would range from a 6% decline to a 2% increase over 2014 even as capital spending drops 60% to stay within cash flow. Just in the last couple of months, the company negotiated price cuts with suppliers that will drop the cost of its already low-cost wells another 18%, “and we expect there is still plenty of room to improve upon those expected savings,” its press release noted.

Two days later WPX Energy (NYSE: WPX) said it would spend roughly half of what it spent last year in 2015. While overall production adjusted for asset sales is expected to dip 4% this year, crude output is headed 15% to 20% higher.

WPX has limited incentive to cut back with two-thirds of this year’s expected oil output hedged at nearly $95 per barrel. Similarly, Jones has 93% of its forecast crude production hedged at nearly $85 per barrel.

With the May 2016 West Texas Intermediate futures contract at $63 a barrel, companies willing to forego some upside can lock in prices very likely to turn a profit, especially given the widespread discounting in oil services that’s likely to continue for a while.

For the moment, the highest U.S. oil output in 32 years is still exacerbating a global glut that could exhaust worldwide storage capacity sometime this year unless relieved by growing demand.  U.S. government forecasters expect slower growth but no letup in domestic crude production over the next two years.


The same report anticipates global demand catching up to supply sometime late this year.


Demand is set to rise by a million barrels per day this year and as much the next, and in 2015 for the first time in many years the U.S. will contribute to that as much as China, with each requiring an extra 300,000 barrels per day.

If that projection proves correct, record developed world stockpiles covering two month’s of crude consumption might not loom so large.

But for the moment oversupply persists and is steadily depleting spare storage capacity. The extent of that oversupply, domestically at least, could grow in the spring as refineries that have recently operated at a breakneck pace catch up on maintenance ahead of the summer driving season.

Very recently, forecasts for $80/bbl crude have again grown more frequent than those calling for $30/bbl. While oil should get back to that level eventually, it will only do so when global demand is sufficiently high. That’s because $80 crude would very likely stimulate additional gains in U.S. output, possibly for years to come if producers informed by the recent plunge end up hedging more of their production further into the future. And the world doesn’t seem particularly ready at the moment to  accommodate such ambition.

China’s consumption increases have already slowed, hurt by an economic malaise belying the robust official growth statistics. The slowdown in that engine of global growth has, in turn, spread to China’s commodity suppliers in Latin America as well as crude exporters in the Middle East, two regions that alongside China have been big contributors to global oil demand in recent years.

Moreover, many developing countries, including India, Indonesia and Egypt, have used the recent price drop to reduce or eliminate government subsidies for fuel buyers. That means those markets could prove more sensitive to higher prices than in the past.

That’s a lot of hurdles crude bulls must sweep aside to get oil back to where it traded just a few months ago. It could happen, but only if global demand makes rising US supply seem like a good idea.

It’s worth noting, meanwhile, that U.S. energy stocks may already be pricing in that outcome, in getting back almost to where they were when crude was, in fact, at $80/bbl in October.

With so many ready to speculate on the best-case scenario, we remain cautious.